Why are Canadian Consumers Opting for Long Term Car Loans?

With personal debt levels for the average Canadian consumers reaching some of their highest levels in the last 10 years, recent trends have shown an increase in long-term car loans, given the allure of lower monthly payments. New mortgage rules in Canada have increase debt concerns for families and households, and this is helping to influence the decisions made by Canadian consumers looking for cheaper financing when making automobile purchases.

Canadian Car Buyers Look to Lower Monthly Payments

When looking for the reasons to explain why these recent trends have emerged, many of these changes are seen stemming from recent moves by the Bank of Canada to reign-in excessive borrowing practices. Most of the Bank’s focus has been directed at mortgage debt but there have been indications that suggest this could extend to into the auto-lending sector as well.

The increased popularity in long-term loans when purchasing new vehicles in Canada has shown dramatic increases in recent years, as potential buyers look for ways to cut back on a central component of the family budget – the monthly car payment. At this stage, reports from J.D. Power and Associates are showing that a majority of the Canadian car buyers who borrow money in order to finance their automobile purchases are taking out loans with contract periods that are longer than six years. This is a massive difference from what was seen just 5 years ago, when less than 15% of Canadian car buyers had loan periods of this length

Recent Trends Get the Bank of Canada’s Attention

In fact, these trends in consumer debt have been so volatile that Bank of Canada Governor Carney has issued public warnings suggesting that personal debt in Canada has reached unacceptable levels, and these warnings have picked up in terms of urgency this past year.
In the first quarter of 2012, personal debt in Canada rose to 152% of disposable income, which is an all time record for the country. Carney’s warnings were echoed by recent statements from the IMF and the Canadian Finance Minister (Jim Flaherty), who moved several times to enact tighter mortgage rules as a means for slowing down a potential bubble in the housing market. But these moves ultimately increases the total costs of buying a home, and when taken into consideration with stalling income growth, many Canadians have found themselves looking for ways to reduce monthly payments in other areas.

Rise in Interest Free Loans

With all of these factors coming together at once, automakers and financial institutions looking to increase sales have begun to offer more interest-free loans with contract periods lasting up to eight years. This essentially means that consumers are being offered free money for the first seven years at neighbourhood car dealerships – a key indication that automakers are using any and all means available for luring potential buyers into their showrooms.

The recent surge long-term car loans shows that households are experiencing added financial pressures in other areas and consumers are looking for ways to either extend their payments or to simply lower their monthly burdens in order to free additional disposable income.

When seeing “easy money” loans of this type, it will not be a major surprise to see large growth in non-mortgage related debt in the coming year. In 2007, 17%of car buyers traded in a vehicle that was attached to a loan which was not fully paid. This year, the number has risen to 26%, so trends in rolling debt have picked up speed.

It appears, at this stage, that Canadian car buyers do not think about car costs in terms of their total values, but rather in terms of monthly payments. Canadian car owners are finding themselves in a position where the main objective is maintaining lower payment obligations in the near term. Additionally, we have seen declines in the use of lease agreements as a means for purchase. Monthly payments for vehicles that are based on leases tend to be much lower than the monthly payments that are associated with loans. Prior to the 2008 financial crisis, over 40% of Canadian consumers leased their vehicles instead of financing these cars or purchasing the cars outright. Since the recession, leasing has seen dramatic decreases, representing a mere 17% of total car transactions over the last year. Looking forward, these trends could prove critical in determining the level of personal debt accumulated by Canadian consumers.

Byline

Author Richard Cox teaches International Trade and Finance at the university level. His work has been featured in FX Street, Waterbury Research, Athena Energy, InterTrader, and MarketBulls.net, and he’s a contributor to the corporate blogs of Car Loans of Canada and Keystone Auto Loans.